By Tiernan Ray

UBS’s Steve Milunovich today reiterates a Sell rating on shares of Hewlett-Packard (HPQ), writing that he’s encouraged by hints in the company’s 10-K filing, made last week, that it would consider selling assets, but that it’s not likely to be what he’s been hoping for, namely a splitting off of the personal computer and printer operations.

Milunovich was referring to the single phrase “[HP] continues to evaluate the potential disposition of assets and businesses that may no [longer] help us meet our objectives,” contained in the filing. That phrase helped give the stock some new life on Wednesday, when media picked up on it as a clue to possible future restructuring initiatives.

CEO Meg Whitman is in the hot seat just like an NFL coach, observes Milunovich:

Last “Black Monday” a number of NFL GMs and coaches were fired as their teams underperformed. HP has suffered too many changes at the top, so we think Meg Whitman has some time to execute her planned turnaround. Still, shareholders likely are as impatient as unruly football fans. Although we don’t think the turnaround will work, the stock might find a bottom in anticipation of eventual change.

However, although Whitman needs time to complete various priorities, a breakup still is the best long-term thing for HP, argues Milunovich:

A break up is in the long-term interest of shareholders. Bill George, Harvard professor and former CEO of Medtronic, penned an article in which he argued that HP should split as we’ve described: With 330,000 employees and $120 billion in revenue, HP has become too big to manage. It is really two businesses: a commodity personal computer and printer business and an enterprise systems, services and software business. The characteristics of these businesses are entirely different.

Unfortunately, Milunovich thinks HP couldn’t even manage a splitting off of PCs at this point, because it’s not yet healthy enough to support its debt burden:

We have argued that HP should be broken up though the company likely does not have the capacity to do so over the next 12-18 months given the state of its balance sheet and weakened fundamentals. After excluding HPFS external debt and short-term commercial paper, we estimate HP’s core debt to be roughly $18 billion. In addition, the company has roughly $5 billion in other obligations and commitments. Including an additional $2 billion in breakup costs/business investment, a split HP would need to shoulder more than $25 billion in debt at an investment grade level. Our attempt at quantifying HP’s breakup capacity suggests that such an event would not be feasible until at least mid-2014 [...] We are not credit analysts, but our sense is that the PC and printer businesses would be able to assume roughly $5.5bn of debt. Although these two have a more variable cost structure, we think a debt/EBITDA ratio of 1.0x would be required by bondholders given an inherent lack of visibility. Our view is that HP’s Technology Solutions Group could carry $12-15 billion of debt depending on an improving EBITDA margin in HP Services. This amount would result in a debt/EBITDA ratio of 1.9x, just below Computer Science’s current multiple of 2.2x. Ratings on CSC bonds are BBB with a five-year CDS hovering around 150bps. A haircut versus CSC’s ratio would account for increased variability in HP Software and ESSN as well as potential disruptions associated with restarting the new entity. Given these assumptions, most breakup scenarios we calculate incur sizable shortfalls in debt capacity post-breakup. In our view, the company will need to rely on some improvement in fundamentals, asset sales, and time to reduce its debt load before it can comfortably split up.

Another option, writes Milunovich, is to sell the company’s “Infrastructure Technology Outsourcing” business, which could boost pre-tax profit margin as well as the balance sheet:

In our rough calculations, HP might sell ITO near 6.0x F2014E EBITDA of roughly $1 billion. Coupled with $1.6 billion in debt, our sense is that such deal would result in an equity value near $4.5 billion. ITO could fetch a higher multiple if operating margins rebounded to double-digits.In our model, selling ITO would be accretive to the company’s EBITDA margin by nearly 100bps in F2014. It also could improve the balance sheet by $6 billion, making a potential breakup more comfortably achievable.

Milunovich concludes the stock will back off of recent gains:

We continue to think the stock’s recent move higher from $11.50 is corrective within a bearish trend, aided perhaps by profit taking on the short side. The stock now rests at the same point it did following the company’s disappointing analyst day—a meaningful resistance gap that will be difficult to fill. Now facing strong resistance, technically we see more risk to the downside. The stock’s point-and-figure count remains well below $10.

HP shares are down 2 cents today at $15.12.

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